Catalysed by the Covid-19 pandemic, progress towards the full digitalisation of the trade ecosystem has transformed what was once a future vision to a near-term possibility. But if the benefits of digital trade are to be unlocked for all, building the right foundations will be key.

From blockchain to artificial intelligence, big data and analytics, the application of new technology is bringing the fully digitalised future of trade finance ever closer. However, in order to capitalise on the opportunity, the ecosystem must lay the groundwork to ensure that, when the time comes, every actor is ready to plug in.

“We’re on a digital journey and the landscape is changing rapidly, with different areas transforming at different speeds,” says Merlin Dowse, global trade product manager at J.P. Morgan. “As we build the trade finance system of the future, it’s vital that no-one is left behind.”

Numerous industry initiatives are underway to drive critical mass in digitalisation, from lobbying for legal reform to the publication of the Uniform Rules for Digital Trade Transactions. In parallel, open trade standards are being developed in order to digitalise trade at scale.

“Through this advocacy for standards, the legal entity identifier (LEI) has been identified as an important tool for promoting and democratising trade digitalisation,” says Dowse.

The LEI is a 20-character, alpha-numeric code that uniquely identifies participants in financial transactions, with each LEI connecting to key reference information about an entity’s ownership structure.

Originally launched by the Global Legal Entity Identifier Foundation (GLEIF) following the global financial crisis as a way of creating transparency in the derivatives markets, the LEI initiative is driven by the Financial Stability Board and the finance ministers and governors of central banks represented in the G20. In recent years, however, an increasing number of actors in trade and supply chain finance are awakening to the benefits of wider LEI usage.

“The LEI is a foundational passport that is technology agnostic – it can be leveraged everywhere, from APIs to blockchain platforms. Whatever new innovation emerges in 2022, the LEI is the identifier that supports the technology you’re looking to use and implement,” says Dowse.

A single passport for every interaction

In its day-to-day activities, a company can be known by multiple names, such as its registered legal name, trading name, ‘doing business as’ name or commonly abbreviated name. To further add to the complexity, manual data entry errors, typos, or truncations where a full name won’t fit in a form field can mean that there can be dozens of different strings of characters all referring to the same entity – and when they transact with their banking or technology partners, the web tangles even further.

“Corporates have to connect with multiple providers, each of which issues them with a client reference number that is meaningless outside of that provider’s system,” says Dowse. “Every time they interact with a third party, they have to share their information again.”

Reducing all of this to one unique identifier in the shape of the LEI allows for interoperability across networks and removes friction, saving time and costs.

But it isn’t just companies that stand to benefit. In a strongly worded missive to all retail banks in mid-2021, the Financial Conduct Authority, the UK’s financial regulator, highlighted “several weaknesses” in many institutions’ financial crime controls, calling for better governance, due diligence and monitoring.

“Banks are being told to do better on verifying parties to transactions,” says Dowse. “The LEI is an enabler for a more efficient process. Banks need to start thinking about how they can adopt the LEI as a data field in every transaction, as they are doing the due diligence to support the needs of their clients. It helps mitigate risks from a corporate standpoint, and for banks it can help prevent fraud.”

Because the LEI registration process calls for the same sort of client data as that used by banks in verifying customer identity as part of their normal anti-money laundering (AML) and know your customer (KYC) procedures, it can be embedded into these procedures with no extra steps, says Dowse, who adds that 45% of J.P. Morgan’s corporate investment bank clients now have an LEI.

“However, those are large corporates,” he says. “Where the real adoption needs to be happen is among small and medium-sized enterprises (SMEs), because this is where the benefits will be felt the most.”

Addressing the trade finance gap

The importance of legal identification at the personal level is recognised in the United Nations’ Sustainable Development Goal 16.9. The LEI extends the concept to firms – and when a firm can be accurately and efficiently identified, it opens up significant opportunities, not least access to trade finance.

According to recent data from the Asian Development Bank (ADB), the trade finance gap is now at a record US$1.7tn, with SMEs the most affected. To understand the reasons behind this, the multilateral organisation polled 79 banks from 43 countries and 469 firms from 72 countries, and almost three-quarters cited AML and KYC requirements as the biggest barrier to meeting the financing needs of small businesses.

Effectively, in many cases the cost of onboarding SMEs makes providing them with trade finance prohibitive.

The LEI can solve for this by giving confidence around who is who, who owns whom and who owns what in a way that is quick and effortless, increasing access to finance for SMEs by making information about them easier to come by – as well as enabling them to more easily access digital platforms.

Making remote transacting a possibility

During the depths of the pandemic, where stay-at-home orders pushed the world into remote working, workarounds such as electronic signatures had to be found to keep the paper-heavy world of trade and trade finance moving. Today, having experienced a taste of the digital future, few companies want to return to wet ink signatures.

But ensuring their safety and validity remains a challenge. In order to meet the requirements of the European Union’s eIDAS regulation, for example, an electronic signature must be both uniquely linked to the signatory as well as capable of identifying the signatory.

“The verifiable LEI (vLEI) enables this to happen,” says Dowse. “It combines the organisation’s identity, represented by the LEI, a person’s identity represented by their legal name, and the role that the person plays for the legal entity. This gives certainty over who the authorised persons are within that organisation who can transact from a corporate perspective.”

The benefits to this for trade could be enormous – which is why the Onyx by J.P. Morgan team is currently working with GLEIF on a proof of concept that the bank will seek to incorporate into a number of its existing and soon to be deployed digital trade solutions.

“If I know who you are based on your company’s ID and your digital ID, then I can open doors for you from a digital banking perspective and enable smarter, less costly and more reliable decisions compared to manual, less trustworthy attestations,” adds Dowse.

The time to adopt the LEI is now

Because of the many possibilities it offers to trade, around the world, industry bodies, regulators and policymakers are working to promote adoption of the LEI. In its recent roadmap for digitally connecting and facilitating interoperation among existing trade finance networks, the International Chamber of Commerce (ICC) explicitly identified the LEI as a “digital trade enabler”. Meanwhile, early 2022 will see the US Customs and Border Protection agency launch a test of the LEI as a means to identify foreign business entities and supply chain roles in order to provide it with accurate supply chain insights.

A 2019 study by the ADB found that, even for the smallest companies in the developing world, the LEI is both affordable and easy to obtain – and with banks such as J.P. Morgan now directly embedding LEI issuance into standard client onboarding processes, more and more entities are gaining the information they need to transact with confidence.

“The direction of travel is clear,” says Dowse. “For the time being, the LEI is not mandated by the regulators for trade – but why wait until it is? The opportunity exists right now to leverage the benefits that it can bring to your organisation as you begin this digital journey.”

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